Categorie: Banks

The topic of this year’s Jackson Hole was, in not so many words, the fading power of central banks which for the past decade had been the only game in town. However, with interest rates back to record lows, and the ECB (and soon Fed) set to restart QE, the outcome will be even worse than last time, sending the world into Albert Edwards’ infamous deflationary ice age.

But one didn’t have to go all the way to Wyoming to observe the waning power of central banks. A quick look at the following chart from Bank of America would have sufficed.

As BofA’s equity derivatives team led by Stefano Pascale and Benjamin Bowler notes, the year 2018 was characterized by the awakening of vol from 2017’s historical lows as investors adjusted to CBs showing less sensitivity for markets.

Meanwhile, Bank of America’s buy-the-dip rule, which worked 9 out 11 times from 2013-2017 when central banks were in their prime, failed 4 times in 2018, and only after the ~20% selloff of Q4 did the Fed flip to a much more dovish rhetoric.

This historical U-turn led to a record start to 2019 for risk assets and one of the sharpest drops in cross-asset vol ever. However, an ominous, if 30,000 ft. view shows that, despite CBs’ best efforts to contain risk this year, the genie can’t be put back in the bottle, and cross-asset vol is unlikely to return to 2017 bubble-lows.

This is shown best through the lens of Bank of America’s GFSI Market Risk indicator, which despite virtually every central bank turning dovish in 2019, is unchanged on average between 2018 and 2019. Indeed, among its cross-asset components and including credit spreads, rates and commodity vol are on average markedly higher in ’19 than in ’18 (less negative numbers indicating higher vol), FX vol has hit new lows this year, and equities and credit are showing similar levels of stress.

Why is this notable? Because as the BofA strategists conclude, “this is important evidence that the market’s trust in central bank support is waning and that the 2017 ultra-low levels of vol are probably behind us.”

In recent weeks we have seen a surprising spike in criticism of central banks by establishment figures, in some cases central bankers themselves, most notably Mark Carney who last Friday remarkably admitted that very low interest rates tend “to coincide with high risk events such as wars, financial crises, and breaks in the monetary regime.” This continued yesterday when 7 months after it praised negative rates, the San Francisco Fed pulled a U-turn and warned that the “Japanese experience”, where negative rates dragged down inflation expectations even more, is ground for NIRP caution.

Then, in an even more bizarre interview with the FT, St Louis Fed president James Bullard made an even more stunning admission – that the Fed no longer has any idea what is going on. To wit:

“Something is going on, and that’s causing I think a total rethink of central banking and all our cherished notions about what we think we’re doing… We just have to stop thinking that next year things are going to be normal.”

There was more. In a series of questions aimed at the Fed in this post-Jackson Hole powerless reality, we brought you some rhetorical fireworks from the head of FX at Deutsche Bank, Alan Ruskin, who lashed out at the central bank with 20 questions, technically statements, that 10 years ago would have branded him a tinfoil-wearing conspiracy theorist (we know, because we asked just these questions back in 2009), among which:

“Will the Fed/ECB buy equities/ETFs? How far are central banks willing to distort underlying value, or is distorting value intrinsic to Central Banking as per the Austrian critique?”

“How much are Central Banks going to be complicit in a collapse in fiscal standards, by buying public sector assets? Will a passive Central bank simply accommodate and facilitate fiscal actions related to MMT?”

“Are we reaching a natural end to the secular decline in inflation and rates that has propelled the asset cycle in the last 40 years. Has asset inflation hidden an even more meaningful deceleration in the natural rate of growth that will evident in the next decade?”

“Is it the Central Banks job to do away with business cycle? And at what price?

Almost all economists and the vast majority of the general population erroneously believe that central banks are, basically, indestructible. And most fail to appreciate that central banks are different from normal commercial banks in just two respects: their ability to earn seigniorage revenue, and to distort accounting rules.

With the current level of liabilities central banks hold those may not be enough. We might be closing in the end of the central banking era.

The income structure of a central bank

Central banks earn seigniorage from the difference between the “printing” costs of the legal tender (monetary base) and its nominal value. In a simplified balance sheet of a central bank, money is visible in the liabilities-side, which also holds the government’s bank account (domestic liabilities) and the reserves of commercial banks and net worth. Net worth includes the capital of the central bank and valuation adjustments for changes in the foreign-exchange rate and investments. A central bank’s assets include securities, foreign-exchange reserves (net foreign assets) and loans (to commercial banks).

Thus, when a central bank buys assets, such as government bonds, it simply either creates money directly or debits the reserves of commercial banks to maintain balance. In the programs of quantitative easing (“QE”, see Q-Review 1/2018), the latter option has been used. The central bank earns income in the form of interest from these holdings. If the liabilities contain required reserves and currency, the central bank has “zero-cost” financing. If the liabilities contain excess reserves and or domestic liabilities, the central bank will need to pay interest.

Losses of a central bank

The central bank can, naturally, also incur a loss. The value of foreign and domestic assets have a significant role in a central bank’s income stream. Usually, losses result from interest obligations, subsidy payments, multiple exchange-rate practices, “guarantee” schemes and unfavorable changes in net asset valuations. With the advent of QE programs, central banks have made themselves vulnerable mostly to the latter (see the Figure).

Figure. The balance sheets of the Bank of Japan, European Central Bank, Federal Reserve and the People’s Bank of China in billions US dollars.

From observing the behaviour of ‘leavers‘ and ‘remainers‘ since the EU referendum in 2016, I have seen first hand how partisanship works as an effective tool to cloud judgement. Once a position of bias becomes ingrained, it has proved next to impossible to see beyond it or for the individual concerned to be convinced of an alternative perspective.

The psychological operation of ‘fake news‘ is now entrenched within society, with both sides of the divide claiming one another to be peddlers of false truths. By my reckoning this is all the more reason why positioning yourself as neither one thing or the other is the only logical way in which facts can be objectively scrutinised.

The role of the Bank of England in the Brexit process is an example of how bias is serving to insulate central banks from impartial and informed criticism. On one side are those who depict governor Mark Carney as an ‘enemy‘ of Brexit, whilst on the other are people who consider Carney as a safe pair of hands amidst a whirlwind of political turmoil. Non-partisan analysis of communications and policy decisions emanating from the BOE is rarely given space to evolve.

For instance, last week the bank published its latest Financial Stability Report in conjunction with a press conference delivered by Mark Carney. Whilst much of his interaction with the press on Brexit was of a similar theme to previous events, one aspect in particular stood out.

Asked by Joel Hills of ITV News about the level of preparation in the event of a no deal Brexit, Carney affirmed that the financial system in which the BOE presides over was ‘ready for whatever form Brexit takes.’ Carney’s conviction stems from a series of bank stress tests that the BOE conducted in 2018 in an attempt to gauge how the financial system would stand up to a crisis greater than 2008. The results as published by the BOE showed that the UK’s banking system was fully prepared.

Indeed, Carney’s confidence was such that he went on to say how the system would continue serving both households and businesses,

Gold and silver bugs are well aware that JPMorgan Chase dominates precious metals futures trading. Russ and Pam Martens of the financial blog Wall Street on Parade just identified how much control they have.

There are more than 5,300 FDIC insured banks in the U.S. Just two of them, JPMorgan and Citibank, hold 75.7% of all precious metals derivative contracts (primarily futures) in possession of the nation’s banks.

Other major Wall Street banks, including Goldman Sachs and Bank of America, are barely even in the game.

The market dominance implied by the outsized positions of these two banks is troubling enough. Metals investors have been pleading with regulators to step in for more than a decade, so far to no avail.

The most interesting part of the story, however, isn’t the monopoly power these banks wield in the futures markets. That’s been pretty well understood. Rather, it is the massive increase in the size of the position since the 2008 Financial Crisis.

Ten years ago, FDIC insured banks held metals contracts valued at less than $15 billion. Today they hold $38.6 billion – an increase of 157%.

Again, JPMorgan and Citi control more than three quarters of that position. It is one more confirmation that the futures markets are hopelessly broken and corrupted. Price discovery is not organic, it is rigged.

Regulators turned a blind eye as the bullion banks issued freshly printed contracts to any and all speculators willing to bet on higher gold and silver prices. There is effectively zero constraint on the supply of paper contracts. Demand is never enough to overwhelm supply and push prices consistently higher.

Piles of evidence now show the bullion banks using their dominant position and inside information to rig price movements lower – by hook and by crook. They profit over and over again from their huge, and perpetually growing, short position.

We continue to marvel at the lack of concern from regulators. These banks are, at this point, in plain view building monopoly positions in the highly leveraged futures markets. And they may be relying on price rigging to make those positions profitable.

The War on Cash isn’t a conspiracy theory. It’s an open agenda. It’s being driven by an alignment of interests among bankers, central bankers, politicians, and Silicon Valley moguls who stand to benefit from an all-digital economy.

Last week, Facebook – in partnership with major banks, payment processors, and e-commerce companies – launched a digital currency called Libra. Unlike decentralized, free-floating cryptocurrencies, Libra will be tied to national fiat currencies, integrated into the financial system, and centrally managed.

Critics warn Libra is akin to a “spy coin.” It’s certainly not for anyone who wants to go off the financial grid.

Many of the companies involved in Libra (including Facebook itself) routinely ban users on the basis of their political views. Big Tech has booted scores of individuals and groups off social platforms for engaging in “far right” speech. If Libra one day becomes the predominant online payment method, then political dissidents could effectively be banned from all e-commerce.

You can still obtain some degree of anonymity in the offline world by using paper cash. But that will become impossible in the cashless future envisioned by bankers.

Last week, Bank of America CEO Brian Moynihan touted new developments in digital payment systems while speaking at a Fortune conference. He said, “We want a cashless society…we have more to gain than anybody from a pure operating costs.”

They gain – at the expense of our financial privacy. A cashless society is the end of a long road to monetary ruin that began many decades ago with the abandonment of sound money backed by gold and silver.

Stefan Gleason is President of Money Metals Exchange, a precious metals dealer recently named “Best in the USA” by an independent global ratings group. A graduate of the University of Florida, Gleason is a seasoned business leader, investor, political strategist, and grassroots activist. Gleason has frequently appeared on national television networks such as CNN, FoxNews, and CNBC and in hundreds of publications such as the Wall Street Journal, The Street, and Seeking Alpha.

Bloomberg would have us believe that the banksters are quaking in their boots over the possibility that Chinese-style payment apps and a truly cashless economy will be making its way to the West in the near future. But is this the banksters’ nightmare or their ultimate dream come true? Find out in this week’s edition of #PropagandaWatch.

Major banks enabled fraudsters to steal billions of pounds of public money through VAT scams, allege documents obtained by the Bureau. A decade later, tax authorities are still chasing the money through the courts.

Traders in London facilitated the so-called carousel fraud by organised crime gangs in 2009, which involved the trading of carbon credits, permits which allow a country or organisation to emit greenhouse gases.

The gangs imported millions of carbon credits from outside the UK without paying VAT on them. They sold them on to traders adding 20% to the bill as if they had paid VAT. What made these frauds different was that the last link in the chain would be a respectable financial institution such as Deutsche Bank, Royal Bank of Scotland or Citibank and these institutions bought the credits at a discount and then claimed the VAT (which had never been paid) back from the Revenue.

In just eight weeks in 2009 they claimed back £300 million before the Revenue stopped paying up and HMRC is still pursuing that money though the courts.

The fraudsters moved their operations from one country to another as different administrations shut the frauds down which has made it difficult to trace the full picture. It is estimated the fraudsters stole €5bn across Europe but many of the key players have never faced justice.

Now the German non-profit media organisation CORRECTIV has coordinated 35 newsrooms across Europe to put the jigsaw together. The Bureau and the other teams of investigative journalists have scoured thousands of newly obtained documents and tracked down some of the participants in the fraud as part of a project called Grand Theft Europe.

The documents reveal in great detail the allegations made against Deutsche Bank, Royal Bank of Scotland (RBS) and Citibank and the broker companies who sold them the carbon credits. It is alleged the banks and brokers did not do enough to ensure the credits they traded were not connected to fraud.

The current civil cases involve RBS – now called NatWest Markets Plc – which is being sued for £71m and Citibank which is being sued for £14m by liquidators of a string of companies involved in the fraud. The companies that absconded with the VAT have gone into liquidation.

This risk could not be more evident today. Not only have we seen large downgrades to consensus growth estimates and central banks’ expectations of GDP and inflation, leading indicators also point to a much weaker economy ahead.

There are similarities with 2008 that we should not ignore.

A massive China stimulus inflates risky assets and commodities.

Poor macro and earnings data is ignored by markets assuming that all will improve in the second half of the year.

Financial repression is at all-time highs while leading indicators point to a growing risk of recession.

In the first quarter of 2019, stocks have added $9.3 trillion in market capitalization, bonds have gained almost $2 trillion in value. Meanwhile, the Conference Board Index of leading indicators has plummeted for the major economies. The Citi Economic Surprise Index has also fallen, particularly in March, despite a small bounce in the Eurozone at the beginning of the year. Global trade growth, machine equipment orders and manufacturing indices remain poor… while debt soars to another record-high of $244 trillion according to the Bank of International Settlements and the IIF.

The difference with the Asian or the 2008 crisis is that this time the excess risk is hidden under central banks’ balance sheets and will continue to do so.

So, if risk is hidden under a perennial money supply-growth carpet, why should we worry? Because the endgame is not likely to be a 2008-style bang, but a slow, painful and unstoppable zombification of the global economy. As the evidence of stagnation rises, governments get more nervous. What do they do? Stop the monetary madness? Allow high productivity sectors to thrive? Promote deleveraging and prudent investment? No. More white elephants, massive unproductive spending at the expense of taxpayers and savers in what is likely to be yet another massive transfer of wealth from salaries and savers to governments with fancy names.

Our federal systems of justice are failing the U.S. citizenry, miserably. It is a fact, beyond consternation that federal agencies’ willful blindness has fostered Goldman Sachs toxicity to the point that Sachs personnel are brazenly and flagrantly ripping off their own clients.

This reporter has helped document 100s of Wall Street frauds by Goldman Sachs and Bain Capital organized criminal enterprise in the U.S. by this writer’s year long Wall St Fraud series that includes discussions about the Goldman Sachs toxic culture that the new Sachs CEO, David Solomon, claims to be nonexistent.

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So where are the investigations, arrests, indictments, and convictions?

Unfortunately, the FBI, SEC and Justice Department’s willful blindness, incompetence and issues of duplicitous agents in the Petters Ponzi, Marc Dreier, KB, Fingerhut, Mattel and eToys cases has resulted in the demise of Toys R Us. They don’t seem to care about these flagrant crimes,

As France braced for the 11th week of the Yellow Vest protests, President Emmanuel Macron said that he is not a ‘man of the elite’ as his critics claim. Yet, people told RT he can’t relate to the struggles of ordinary citizens.

In an apparent effort to brush aside the label ‘president of the rich’, President Macron decided to reaffirm that he is a ‘man of the people’.

“If I had been born with a silver spoon in my mouth, or the son of a politician, you could have a go at me. But that’s not the case.”

He made the remarks in the town of Bourg-de-Peage during the third round of ‘national debates’, a series of town hall-like events the authorities hope will help to foster compromise with the Yellow Vest protesters and other critics of the government. Some, however, find it hard to buy Macron’s ‘I’m one of you’ message.

“He obviously doesn’t come from lower-income brackets like some of us do,” a woman told RT on the streets of Paris.

“He can’t understand the everyday problems of French people living on minimum wage,” another Parisian said.

“But it’s not really important what he says now. His future actions will define his presidency.”

Not exactly a man of humble upbringing, Macron comes from a well-off family. Prior to first joining the government as minister of economy and finance, he was an investment banker with Rothschild & Cie Banque.

“He studied in elite schools, as aristocrats do. He was ‘made’ there. The French elite is created this way,” a man told RT.

Even if the president is right about not being born into the elite, his milieu most certainly was, another said.

“Throughout his career Macron has networked with people who were born with silver spoons in their mouths. I think he is more a president for the rich. He is a ‘puppet’ of the big banks.”

In the eyes of his critics, Macron well deserves the ‘president of the rich’ tag after scrapping the wealth tax,

Wonder if you have any insights as to the history of the bank clearing process.

Was the clearing process created mainly so banks could play games and earn interest with peoples’ money

with the reasoning that it was to prevent money laundering?

With technological advances today, one can accept an hour or two for automatic name and account number checks to happen

but 3-7 days seems ridiculous.

Any insights to the creation of the clearing process would be enlightening.

Thank you again

KW

ANSWER: The function of bank clearing began with giro-banking, which originated in the Temple of Delos in Greece. The term refers to the circulation of money. It originated where you could write a check to one person and transfer the payment to their account at the same bank. Effectively, in ancient Greece, you would have an account at the Temple in Delos and instruct a transfer to their account in the Temple. The Romans adopted this concept and thus Roman banking was born.

A central bank emerged after the Dark Ages in the early modern history as a government or state-owned banks. The Dutch were pioneers and financial innovators who not only created this state banking concept, but they also invented insurance. The Wisselbank was the first such bank in Amsterdam which was founded in the Dutch Republic during 1609. The Wisselbank became the model of the central banking system and it spread throughout Europe; first in 1668 in Sweden known as the Sveriges Riksbank and then the Bank of England in 1694.

When smaller private banks began to pop up, the state-owned banks emerged as clearing banks where transfers between the accounts at the central bank took place the same as they did between accounts in ancient Delos.

The Wisselbank actually collapsed in 1790 after it was revealed that the deposits have been used secretly to fund the Dutch East India Company. The manipulation was that they represented themselves as just holding money for safe-keeping. They did not lend money out. So when the bank failed and they had been using the money to fund the Dutch East India Company,

On Friday, one day after Russia and China pledged to reduce their reliance on the dollar by increasing the amount of bilateral trade conducted in rubles and yuan (a goal toward which much progress has already been made over the past three years), Russia’s Central Bank provided the latest update on Moscow’s alternative to US-dominated international payments network SWIFT.

Moscow started working on the project back in 2014, when international sanctions over Russia’s annexation of Crimea inspired fears that the country’s largest banks would soon be cut off from SWIFT which, though it’s based in Belgium and claims to be politically neutral, is effectively controlled by the US Treasury.

Today, the Russian alternative, known as the System for Transfer of Financial Messages, has attracted a modest amount of support within the Russian business community, with 416 Russian companies having joined as of September, including the Russian Federal Treasury and large state corporations likeGazprom Neft and Rosneft.

And now, eight months after a senior Russian official advised that “our banks are ready to turn off SWIFT,” it appears the system has reached another milestone in its development: It’s ready to take on international partners in the quest to de-dollarize and end the US’s leverage over the international financial system. A Russian official advised that non-residents will begin joining the system “this year,” according to RT.

“Non-residents will start connecting to us this year. People are already turning to us,” said First Deputy Governor of the Central Bank of Russia Olga Skorobogatova. Earlier, the official said that by using the alternative payment system foreign firms would be able to do business with sanctioned Russian companies.

To be sure, the Russians aren’t the only ones building a SWIFT alternative to help avoid US sanctions. Russia and China, along with the European Union are launching an interbank payments network known as the Special Purpose Vehicle to help companies pursue “legitimate business with Iran”

The U.S. credit card system siphons off excessive amounts of money from merchants. In a typical $100 credit card purchase, only $97.25 goes to the seller. The rest goes to banks and processors. But who can compete with Visa and MasterCard?

The future of consumer payments may not be designed in New York or London but in China. There, money flows mainly through a pair of digital ecosystems that blend social media, commerce and banking—all run by two of the world’s most valuable companies. That contrasts with the U.S., where numerous firms feast on fees from handling and processing payments. Western bankers and credit-card executives who travel to China keep returning with the same anxiety: Payments can happen cheaply and easily without them.

The nightmare for the U.S. financial industry is that a major technology company—whether one from China or a U.S. giant such as Amazon or Facebook—might replicate the success of the Chinese mobile payment systems, cutting banks out.

According to John Engen, writing in American Banker in May 2018, “China processed a whopping $12.8 trillion in mobile payments” in the first ten months of 2017. Today even China’s street merchants don’t want cash. Payment for everything is handled with a phone and a QR code (a type of barcode). More than 90 percent of Chinese mobile payments are run through Alipay and WeChat Pay, rival platforms backed by the country’s two largest internet conglomerates, Alibaba and Tencent Holdings. Alibaba is the Amazon of China, while Tencent Holdings is the owner of WeChat, a messaging and social media app with more than a billion users.

Alibaba created Alipay in 2004 to let millions of potential customers who lacked credit and debit cards shop on its giant online marketplace. Alipay is free for smaller users of its platform. As total monthly transactions rise, so does the charge; but even at its maximum, it’s less than half what PayPal charges: around 1.2 percent. Tencent Holdings similarly introduced its payments function in 2005 in order to keep users inside its messaging system longer.

European banks have been lending in the United States quiet aggressively because (1) the economy is doing good so there is a demand for loans contrary to Europe, and (2) the behind the curtain view that the euro will decline and the dollar will rise. During the first half of 2017, European banks have lent about $53 billion in US dollars taking the currency risk which they have benefited from as the euro declines. According to Bloomberg, Europeans’ combined market share in the United States rose to nearly 24%.

The concern of some has been that the loans are going into leverage structures once again. In total, banks and other companies issued $494 billion in new leveraged loans 2017, which has been the largest amount since 2011. The European banks at the top of the list are the British Barclays Bank, which bought Lehman Brothers Holdings’ US businesses after the collapse. Barclay’s now controls more than 6% of the market for new loans and is the third largest leveraged loan arranger in the US this year. Barclay’s is also big in issuing credit cards in the United States. The second on that list is Credit Suisse Group AG. Then we have Deutsche Bank, which on the one hand wants to withdraw from US markets, has also been looking at lending in dollars for the same reason of gaining on the currency in the face of a collapsing euro. We see similar policies being adopted in the British HSBC, Swiss UBS, French BNP Paribas, Dutch ING Groep and Credit Agricole.

While many believe that as major central banks continue to push ahead with monetary policy normalization of raising interest rates, they wrongly think that raising rates will hurt the credit market and create a downturn. What they fail to grasp is that rates can rise with no impact provided the economy is expanding, but rates can also rise because there is no demand and government is forced to keep offering higher rates to find buyers of their debt in the real world. It all depends upon what people believe. This is why low rates in Europe have FAILED to stimulate demand when people lack confidence in the future, they will NOT borrow at any rate.

There has been a lot of confusion lately in the mainstream economic media as well as in independent media circles as to the behavior of stock markets in the wake of the recently initiated global trade war. In particular, stocks suffered one of the longest runs of negative days in their history in June, only to then spike just after Donald Trump “officially” began trade war tariffs in July. The expectation by many was that the headlines would cause an immediate and continued downturn in equities markets, but this was not the case. Many analysts have been left bewildered.

This is an issue I have touched on multiple times since the beginning of this year, and it is something I predicted long before Trump’s election in 2016. But it is obvious that the schizophrenic nature of stocks needs to be addressed in a very concise, no-holds-barred fashion, because there are still far too many people who are looking at all the wrong causes and correlations.

First, let’s be clear: stock markets are NOT tracking the news headlines. The past month should have proved this if there was any previous doubt.

It is hard for investors and some analysts to grasp this fact, primarily because for at least the past few years it appeared as though stock markets were utterly dictated by headlines out of Bloomberg, Reuters and other mainstream media outlets. Once investors and analysts became used to this narrative it was difficult for them to adapt when the dynamic changed. They are still living in the past based on an assumption that was never quite correct to begin with.

In reality, headlines never actually dictated stock prices; it was always the Federal Reserve among other central banks.

As I and others have noted consistently, stock market valuations for the past several years have tracked almost perfectly with the Fed’s balance sheet. That is to say, every time the Fed purchased more assets and increased the balance sheet, stocks went up.

After years of the notorious “Fed Put,” we now have an entire generation of investors and market writers that have never experienced a stock environment in which equities actually fall according to the health of their corresponding companies or the economy at large.

Several years ago we showed how the Fed’s then-new Reverse Repo operation had quickly transformed into nothing more than a quarter-end “window dressing” operation for major banks, seeking to make their balance sheets appear healthier and more stable for regulatory purposes.

And this is a snapshot of what the reverse-repo usage looked like back in late 2014:

Today, in its latest Annual Economic Report, some 4 years after our original allegations, the Bank for International Settlements has confirmed that banks may indeed be “disguising” their borrowings “in a way similar to that used by Lehman Brothers” as debt ratios fall within limits imposed by regulators just four times a year, thank to the use of repo arrangements.

For those unfamiliar, the BIS explains that window-dressing refers to the practice of adjusting balance sheets around regular reporting dates, such as year- or quarter-ends and notes that “window-dressing can reflect attempts to optimise a firm’s profit and loss for taxation purposes.”

For banks, however, it may also reflect responses to regulatory requirements, especially if combined with end-period reporting. One example is the Basel III leverage ratio. This ratio is reported based on quarter-end figures in some jurisdictions, but is calculated based on daily averages during the quarter in others. The former case can provide strong incentives to compress exposures around regulatory reporting dates – particularly at year-ends, when incentives are reinforced by other factors (eg taxation).”

Reading through Security Analysis, the roadmap for investing first published in 1934 by Benjamin Graham and David L. Dodd, I learned something quite interesting: The basis of stock valuation had changed quite drastically in the period between 1927 and 1929. The stock buying public “departed more and more from the factual approach and technique of security analysis and concerned itself increasingly with the elements of potentiality and prophecy”, write Graham and Dodd.1

What they mean is that in the pre-WWI world, stocks were typically valued on the basis of a three-part concept: (i) a decent track record of firms’ dividend returns, (ii) a stable and satisfactory earnings record, and (iii) a strong balance sheet, with sufficient backing by tangible assets. The “New-Era” theory of stock valuation reads, summarized in one sentence, as follows: “The value of a common stock depends entirely upon what it will earn in the future.”

Current dividends should only have a slight impact upon a stock’s valuation, and as firms’ asset values did not have an apparent relationship with their earning power, asset values were said to be devoid of importance when it comes to calculating a stock’s “fair price.” A firm’s earnings record was only relevant to the extent that it might indicate what changes in a firm’s future earnings were likely to be expected. In other words, the New-Era theory of stock valuation was quite a break compared to the valuation technique employed in the past.

A Sea Change in Pricing Stocks

According to Graham and Dodd, there were two significant causes why such a change in the approach to stock valuation occurred. First, accounting data of a firm’s past proved to be increasingly unreliable as a guide for making wise investment decisions. The reason for this was rapid changes in demand structures and product and process technologies. Second, the expectation of future rewards became increasingly attractive to many investors, in fact, “irresistibly alluring.”

The New-Era theory of stock valuation, which people followed in the hot phase of the 1927-1929 stock market rally, turned out to suffer from two weaknesses, according to Graham and Dodd.